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Tuesday, April 15, 2014

On Friday, the S&P 500 (SPX) captured downside Target 2 (1822-28; published April 7). On Monday, the Nasdaq Composite (COMPQ) captured its downside Target 2 as well. The market has now reached an important inflection point, which we'll discuss in more detail in a moment.

Numerous major indices, particularly the high beta indices like the Russell 2000 (RUT) and COMPQ have formed clear series of lower highs and lower lows, which is the very definition of a downtrend. It's virtually impossible to look at those price charts and find any technical reasons to be intermediate bullish at the current juncture. Therefore, going on the philosophy of "trade what you see," I'm left with no other option but to continue to favor the bears for the intermediate term -- unless and until proven otherwise.

The bear case is technically solid, and thus has to be considered "preferred," but I'm nevertheless going to devote several paragraphs to talking about the bull case and the other side of the trade, partially because I see very few folks doing so and I feel obligated to bring some balance to the discussion. Longtime readers know I'm an equal opportunity offender of both bulls
and bears; ultimately I don't really care which direction the
market goes, outside of how it impacts my
current positions.

Let's discuss the bull case: bears may want to stay on their toes right now, because the charts have reached a technical inflection point, and it's significant. Here I'm going to briefly digress from the technical discussion, but I'll return to it in a moment.

Digression: The herd is getting awfully bearish lately. I've seen more "crash"
articles show up over the past week than I have in a long time. What's troublesome for bears isn't that these articles are being written, it's that they're being read. Admittedly, this is very anecdotal -- but I write about this stuff, so I've picked up a thing or two over the years regarding mass sentiment and the popularity of articles. Thus the current popularity of crash-type articles bothers me a bit because, from the perspective of market timing, the majority rarely read hardcore bear articles when they "should" -- instead, when they should be reading bear articles, they read bull articles; or articles about flowers and cute fluffy kittens (not necessarily in that order). They usually want bear articles right before a bounce is due.

Certainly we can't trade based purely on anecdotal sentiment like that, but I felt it was worth discussing nonetheless. From a more technical perspective, this inflection point comes about because SPX and several other indices have reached the zone where a corrective wave structure could form an intermediate base. Let's start off with the NYSE Composite (NYA) to illustrate this.

Since I often try to foresee and discuss the market two or more turns in advance, I opened this discussion in Friday's article with the following:One of the questions I indirectly raised earlier is: "How might the
market punish the newly-converted bears?" There are, of course, no
guarantees that it will, but it's a strong possibility. So, instead of
cluttering up the SPX chart, I've used the NYSE Composite (NYA) to
illustrate two possibilities for market curveballs.
The first curveball potential is a surprise intermediate bottom in wave
C. C-waves typically reach approximate equality with A-waves, as shown
by the green measured-move boxes on the chart below.
The second curveball potential is for a quick drop that captures the SPX
target 2 zone, which is followed by a retracement rally (to punish the
new bears). I've shown this option in black on the chart below -- if
this plays out, expect SPX to follow a similar path. Note there is
absolutely no technical reason for me to consider such an outcome, this
is merely based on trying to determine what might cause the greatest
amount of pain to both the bulls and the bears at the current juncture.
The black path would also leave the greatest number of options open,
which is another thing the market often likes to do.
Here I'd again caution readers to watch the crash channel on SPX, and
thus not entertain these other options as long as SPX remains within
that channel.

SPX broke out of the crash channel later in Friday's session. Of note is the fact that NYA has, so far, followed Friday's proposed black path very well -- in fact, the last three directional moves tracked the black dashed line so well that the price action essentially covered it up completely (I deleted the overlap on this chart -- the original can be compared in Friday's article).

When I study NYA on the one-minute chart, it suggests the rally since Friday's low was impulsive -- and that suggests at least one more wave up is due. I would not be at all surprised to see the black path fully realized over the coming sessions.

SPX is also hinting at a near-term bounce. My main regret on this chart is that, on Friday, I strongly considered splitting Target 3 into two zones (due to the wave structure): 1810-14 and 1798-1804. As a result of not following my instincts, Target 3 may have to wait. Of note is the fact that if SPX rallies into the near-term target and then returns to break 1812, bulls are probably in serious trouble, and Target 3 would almost certainly be far too conservative in that event.

On the bigger picture SPX chart, we can see that, on Friday, SPX tested the old black trend line. One more reason the current inflection point has to be noted and respected, at the very least.

I've spent a lot of time talking about the bull case because it's simply too obvious to ignore, and I feel it's irresponsible to only discuss one side of the trade, especially at an inflection point. Nevertheless, I am continuing to favor the bears in equities and will treat the (projected) bounce as a selling opportunity until proven otherwise.

One of the charts keeping me in the intermediate bear camp (with equities) is the 30-year bond (USB). Outside of calling the b/(2) bottom on April 7, there's been no change to this chart or its projections since I turned bullish on USB back in February. Note the long bond has now broken out above the dashed red resistance line, which is the first true confirmation of my intermediate bullish stance in bonds. Markets often become whippy around important price zones, so some backing and filling around that breakout isn't out of the question.

In conclusion, I continue to favor the intermediate bear case for equities because, given the current charts, I have no choice. I've discussed the intermediate bull case in depth because I feel we at least have to respect it, since, for more than a year, this market has repeatedly surprised to the upside. The bottom line is this: Near-term, more upside would not be unusual, and I've mapped out the key intermediate upside levels as best I can. While the bull case bears respect, until those key levels are reclaimed, I have to treat any bounces as selling opportunities. Trade safe.

Follow me on Twitter while I try to figure out exactly how to make practical use of Twitter: @PretzelLogic

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